(originally posted on April 17, 2010)
There is much talk these days about taxing the rich, or as the president says, “those who make over $250,000 a year.” While this idea rings a bell in the minds of followers of populist politicians, it makes little sense economically—and may, in fact, be dangerous. The danger comes when one considers how easy it is for a person who earns more than $250,000 (and is asked to pay these ever-increasing taxes) can convert himself into a person who earns less than $250,000: all he has to do is stop working so much. While society would benefit greatly if politicians and sleazy lawyers decided to play golf, rather than work, what we really don’t want is for heart surgeons to decide to start playing golf on Fridays.
To see why Doc might decide that he’d rather begin his golf weekend on Fridays than perform surgeries, consider how our government taxes income at the margin. If the top marginal tax rate is 38%, our Doc doesn’t pay 38% of everything he makes to Uncle Sam; he pays 38% of what he earns above, say, $250,000 and a secondary lower rate on income below that amount. Anyone who earns more, therefore, pays more. So, for every dollar earned on surgeries performed after Doc earns $250,000, he gets to keep only 62 cents. If he decides 62 cents on the dollar isn’t worth the effort, Doc can lower his marginal tax rate by grabbing his sticks and heading to the first tee.
This illustrates one of the great (or not!) aspects of our so-called progressive tax system. When marginal tax rates rise to the point that industrious workers feel they are being ripped-off by the government, they can lower their taxes by reducing their work effort. When this happens, Doc works on his game, the makers of golf clubs realize sales increases, caddies and 19th hole bartenders earn more in tips. Everyone, it seems, is free to make the choice that makes him happiest. Except, perhaps, the patient who needs surgery on Friday.